Unintended consequences: Sanctions on Russia hurt US dollar dominance

The US dollar, the dominant global currency since 1944, may lose some of its luster due to the American-led sanctions against Russia over the turmoil in Ukraine. The greenback has been fading in favor since the global financial crisis in 2008.

The US-led sanctions against Russia may have backfired on the US
because it threatens to “hasten a move away from the dollar
that’s been stirring since the global financial crisis [in
2008],” Rachel Evans at
Bloomberg wrote. In an unexpected turn of events, Hong Kong’s
central bank has bought more than $9.5 billion since the start of
July “to prevent its currency from rallying as the sanctions
stoked speculation of an influx of Russian cash,” she noted.

“OAO MegaFon, Russia’s second-largest wireless operator,
shifted some cash holdings into the city’s dollar,”
according to Bloomberg. “Trading of the Chinese yuan versus
the Russian ruble rose to the highest on July 31 since the end of
2010, according to the Moscow Exchange.”

In March, after Crimea voted to secede from Ukraine and join
Russia, the US
and European
Union imposed visa restrictions on Russians and Crimeans whom
they considered “most directly involved in destabilizing
Ukraine, including the military intervention in Crimea.”
America and the EU expanded their economic punishment later in
the month, as well as twice in April, once in May and twice in
July, according to Debevoise & Plimpton, an international
financial law firm.

In the latest
round of sanctions, issued on July 29, the European Union
imposed broader sanctions to “limit access to EU capital
markets for Russian State-owned financial institutions, impose an
embargo on trade in arms, establish an export ban for dual use
goods for military end users and curtail Russian access to
sensitive technologies particularly in the field of the oil
sector.” President Barack Obama announced the US would also
be “blocking the exports of specific goods and technologies
to the Russian energy sector,” “expanding sanctions to more
banks” and “suspending credit that encourages exports to
Russia.”

The dollar’s dominance has shrunk over the last 13 years, from 72
percent of global currency reserves to 61 percent today,
threatening the position that the greenback held since the
Bretton Woods Conference in July 1944, when delegates from 44
Allied countries met in New Hampshire to hammer out a way to
regulate the international monetary and financial order after the
conclusion of World War II. Each signatory agreed to adopt a
monetary policy that maintained the exchange rate by tying its
national currency to the US dollar and to prevent competitive
devaluation of its money. At the time, the dollar was pegged to
the price of gold. In 1971, President Richard Nixon took the US
off the gold standard, and the American banknote became the
reserve currency around the world. Certain commodities, like oil,
are priced in US dollars, regardless of the country of origin.

“The crisis created a rethink of the dollar-denominated world
that we live in,” Joseph Quinlan, chief market strategist at
Bank of America Corp.’s US Trust, which oversees about $380
billion, told Evans. “This nasty turn between Russia and the
West related to sanctions, that can be an accelerator toward a
more multicurrency world.”

The wording of the economic penalties may also negatively impact
the greenback’s standing as the world’s reserve currency.

Historically, US sanctions prohibit companies from using US
dollars in the targeted country (like Iran or Sudan), Frances
Coppola wrote in Forbes in mid-July. But the present sanctions on
Russia focus on “US persons” providing companies with
long-term financing in any currency. Some of the targeted
businesses include those in the energy industry, including
Rosneft and Novatek, and those in the financial industry, like
Gazprombank (the financial arm of gas giant Gazprom) and the
Russian state development bank.

“It is perhaps not obvious why an energy company would want
to borrow in Euros, since oil and gas are priced in
dollars,” Coppola
wrote. “But borrowing in Euros could be a way round the
sanctions.”

Banks could also use derivatives “or even just basic foreign
exchange facilities,” she added. But with the EU joining in
on the sanctions, Euro funding may be “rather hard to come by.”
But, Coppola noted, “It’s still clever.”